Outlook: Five myths about cutting the deficit

Nov 29, 2010

William G. Gale, a senior fellow at the Brookings Institution and co-director of the Urban-Brookings Tax Policy Center, will be online Monday, Nov. 29 at 11 a.m. ET to discuss his Outlook article titled 'Five myths about cutting the deficit.'

William G. Gale

Hi everyone -- thanks for joining today. I'm here to discuss my Five Myths on deficit reduction piece from this past Sunday. I also want to recommend the excellent and related "Topic A" discussion in Sunday's Post on the best ideas on deficit reductions in the recent proposals. Looking forward to good questions and discussion. Please feel free to submit questions

From the 1950 Brookings monograph 'The Cost and Financing of Social Security,'by Lewis Meriam and Karl Schlotterbeck: "The [Social Security] Trust Fund is a fiction, serving only to confuse." That quote is NOT taken out of context. William G. Gale of the Brookings Institution on 11/28/2010: "Supporters of Social Security argue that the program's 2010 surplus, combined with its projected 27-year solvency, should exempt it from the budget axe. " Mr. Gale offered no comment on the supporters' claim about Social Security's solvency, so I assume that he agrees with it. So Mr. Gale should please explain why he and those supporters aren't confused about the "Trust Fund."

A: William G. Gale

I may not have been clear enough about SS. My point was that the program is running a long-term deficit, despite the current trust fund surplus, so I fall into the "the trust fund is not the be all and end all" camp. But it is not a fiction either, it has legal significance -- because the government can only pay out benefits from the trust fund so if the TF is exhausted benefits literally have to stop or be restricted by what comes in that month in payroll taxes -- and therefore it has political significance as well. The main point is that SS revenues and benefits have to be aligned in the long run.

The government's authorization to overspend will end in April 2011. Do you think that Congress will resolve this by increasing the debt ceiling? If that is done, will the value of the dollar deflate? Will April be a pivotal moment as far as our economic future is concerned?

A: William G. Gale

I hope that the debt ceiling is not used as the mechanism to address the fiscal issue because any such decision will have to be made in a hurry and will be pretty ugly. Shutting down the government, of course, is also a pretty ugly solution and it backfired on those who fomented it in the 1990s.

How much of our national debt do we owe the Saudis? I.e., what is the value of the U.S. Treasury bonds that they own? One thing that confirmed my suspicions from the WikiLeaks cables is that they expect us to fight their wars for them. Can we tell them that we choose to not pay back some of our monetary debt to them because of the debt they owe us for keeping them free from the Iranians, Russians, et al?

A: William G. Gale

I don't know the answers to these questions, which are more security- , defense- and foreign-policy related than economic-related. These are certainly very legitimate public policy issues, and it would be great if we could resolve them, but it'd be a mistake to think that this type of thing will get us out of the fiscal situation we face. (likewise, going after waste, fraud, abuse, earmarks, salaries of government workers, etc. are not going to solve the fiscal problem.)

My questions come in the form of two comments: 1. You state that the United States does not confront an imminent fiscal crisis because it will not materialize until around 2020. But given the size of both the U.S economy and bureaucracy compounded by the projected huge near term deficits of $1 trillion per year, isn't the crisis really upon us now and isn't it urgent we act immediately to avert the crisis? Put simply the U.S. economy is like a huge oil tanker that takes a long time to turn around. 2. Are budget adjustments, taxes and program restructuring, sufficient to avert the crisis? Truthfully, the U.S. administration is a nineteenth century structure overlayed with a mid-twentieth century bureaucratic remodeling and then of course a huge number of additional rooms to support an expanding family. Doesn't this crisis require a reformation of goverment, especially at the federal level within the federalism framework to be effective? Simply put, in our last crisis we grew out of the problem benefiting from lower taxes and a restructuring of our industry and finance system, this time we need to restructure and modernize government itself to grow out of the problem.

A: William G. Gale

Both good questions. Very briefly, yes we should make an effort to make these changes now -- not to cut spending and raise taxes now because we are in a very weak recovery and that would hurt -- but rather to make NOW the plans and commitments to cut spending and raise taxes IN THE FUTURE.

With respect to the structure of government, there's no doubt that any institution as large as the federal government needs ongoing reform. The question you ask here is really part of a larger debate -- do we solve the deficit problem by having government do a little less of everything it does? or do we solve it by fundamentally restructuring the role of government in society? Basically, everyone who wants to fundamentally restructure some aspect of government in society (whether it is tax policy, the governent's role in world military issues, privatization of SS or medicare, etc.) wants to do the latter, at least for their policy, but our government is not well-designed to make a series of huge changes all at once. We may need to settle for now with having the same old government doing less of what it has done in the past (and raising more revenues). In other words, we shouldn't let the "perfect" of structural reform be the enemy of the "good" that is deficit reduction. If we do, we may end up with neither and that would be very bad. And of course, we should continue our efforts for structural reform, just not let it be hostage to deficit reduction.

Seems to me you missed the most fundamental myth/misunderstanding of the deficit - is it's definition or at least it's definition in Washington. Very few people understand that the "deficit" does not track total government borrowing. As calculated in Washington, the deficit ignores money borrowed from the trust funds. One of the most bizarre effects of this accounting "quirk" is that you can create a "surplus" by using SOME of the money you borrow from the trust funds to pay off publicly held debt. This is exactly what happened at the end of the Clinton administration. The national debt was increasing, but we had substantial surpluses. We then used these "surpluses" to justify cuts to the income tax. Now we are faced with the need to cut Social Security, but if you talk about eliminating the tax cuts that were justified by money borrowed from Social Security, you are accused of class warfare. What am I missing?

A: William G. Gale

You're right that the deficit is not defined well, according to economic concepts. I've written alot on this with Alan Auerbach at Berkeley (and he and Larry Kotlikoff and Jagadeesh Gokhale have truly emphasized this point over the years with generataional accounting). BUT... in this particular current situation, both the reported deficit and the true fiscal status of the government are bad. In contrast, in 2001, for example, people like Auerbach and me were reporting problems with the true fiscal status despite the big "apparent" surpluses that existed back then.

One other aspect of this -- because the Trust Funds basically represent transfers between parts of government, but add to the gross debt, one should always focus on net debt figures not gross debt.

Yeah, I hear you. It is easy to get frustrated. It is perhaps worth noting that our founding fathers designed the government to be slow-moving but that may be a bit of a Panglossian interpretation (I saw Candide this weekend).

I go back and forth on the issue of how optimistic one should be about what policy makers will do. Right now, I feel like it will take a crisis for them to get moving and unless we foment a crisis ourselves (via shutting down the government), it might be awhile before financial markets create a crisis for US debt. (Please, be clear, I am not advocating that, just saying it seems like it will be a long way off.)

It would be better/best/great if they came together and reached a conclusion that at least solved the problem for the next decade.

It's a political premise of the Tea Party that there will never be a political consensus to cut the biggest ticket items as long as there are other options, so the only way to eventually cut them is to starve the beast first (cut tax income). Is there any other way around?

A: William G. Gale

Well, the problem is that cutting taxes doesn't cut spending either! Over 80 percent of people who signed the no new taxes pledge and who voted on Medicare Part D in 2003 (the largest new entitlement in almost 40 years) voted IN FAVOR OF the new spending. Likewise, about 80 percent of those same people voted for a large highway bill the same year.

As I said in the Post article, fiscal discipline only seems to work when it is imposed on both sides of the budget. Starving the beast has not worked and indeed that philospophy, espoused, in 1981 and 2001, led to very large deficits, when it failed.

I could accept (though not agree with necessarily) the whole "no new taxes" approach to the world if it were accompanied with spending cuts that solved the problem, but you rarely hear that, you mainly hear people rant about taxes (which have been at generational lows the last few years) without suggesting a solution. As I mentioned in the article, that kind of thing is not particularly productive.

The way to solve the problem is to address it on both the spending and tax sides -- shared sacrifice is going to be necessary for this. And we expect high-income households to bear some of the added fiscal burden that comes from solving the crisis, the only way to do that is to raise taxes, since high-income households dont benefit much directly from government spending.

Our military commitments seem to be premised in the 50s -- we're the only superpower capable of patrolling the oceans, keeping nukes in submarines and protecting democratic East Asia from China. What has to be done to create a world military based on modern geopolitics in which Germany and Japan are peaceful, prosperous nations and India and Indonesia are major countries with a role to play? Or can our military not be cut (politically) because there are too many Americans economically dependent on its size?

A: William G. Gale

It's a very good question and one I am not the best person to answer. However, it is completely fair to say that just as we need to revisit the social contract (SS Medicare taxes) at home, we should revisit the implicit contract or understandings we have with the rest of the world with respect to security and defense issues. That could well result in a strategic realignment for the US.

I think it was the great British economist James Meade who, decades ago, demonstrated the common sense proposition that government budget deficits harm productivity only to the degree that the projects they finance are less productive socially than any private projects that they displace. Seen in this light, the difference between using borrowed money to build roads, high speed rail, and bridges and using it to blow up things and bribe local officials in Afghanistan is especially striking.

A: William G. Gale

This is a great comment, both because it's right and because it gets lost in the current discussion. The issue isn't (just) the deficit, it is what the government does with the money.

Okay -- so how do you feel about some of the big issues being taken up in this lame-duck session: extension of the Bush tax cuts, Alternative Minimum Tax relief, and the "doc fix" for Medicare? Can we really afford to do all of this and expect to start "turning the ship around" at the same time? Is there any way to avoid such fiscally-irresponsible "business as usual"?

A: William G. Gale

Another great question. It seems like there are three separate issues floating around. First, is cleaning up the ongoing day to day business of the past year -- there are just a bunch of things related to tax rules that have been left hanging -- AMT, estate tax, etc.

Second, is short-term economic stimulus. Somehow that has gotten reduced to the question of how much of the Bush tax cuts should be extended and for how long. That is a very unfortunate shrinking of the topic, though. The Bush tax cuts are by now means the best way to stimulate the economy right now -- they were never designed as stimulus and CBO listed them 11th out of 11 options in terms of their bang for the buck

The third issue is the long-term situation, which they won't do anything about right now, of course, but which hangs over their heads and at the very least encourages them not to do anything that raises the long-term deficit (like making the tax cuts permanent).

Mr. Gale, enjoyed reading your article. R's and D's are clearly divided on the upcoming expiration of the Bush-era tax cuts, and each side is telling different stories on the impact of different plans. In your opinion, what would the effect on the deficit (factoring in the impact on the economy) of allowing all of the tax cuts to expire? What about only allowing the tax cuts on the upper tax brackets to expire?

A: William G. Gale

I think we could find better ways to stimulate the economy in short run than the Bush tax cuts in general and the Bush tax cuts that aid only high-income households in particular. Such options include a payroll tax holiday, a new hiring tax credit, infrastructure investment, aid to the states, etc. CBO has written extensively on this .

The federal government's $800 million stimulus was basically a public sector wash, as state and local government spending decreased about the same amount during the same time. Paul Krugman believes without the stimulus funding that unemployment might have reached 13 percent. What are your thoughts on this?

A: William G. Gale

This quesion highlights one of the interesting things to come out of the recent stimulus efforts, namely that state governments -- because their balanced budget rules, which require them to cut back when revenues fall -- have not helped much in the recent recovery efforts. This (a) reduces the impact of federal stimulus (b) makes federal aid to the states particularly powerful stimulus, since every dollar given to them reduces the amount they need to lay off people or cut spending. Interestingly, this phenomenon is neither new (it happened in the 1930s as well, where the states provided no net stimulus over the decade) nor limited to the US (in Japan in the Lost Decade, subnational governments often moved in ways that subverted the aims of federal stimulus).

It all points to how hard it is to manage an economy as large as ours.

I do believe, based on the evidence I've seen, that the stimulus package has indeed helped stimulate the economy. I won't speculate on whether the unemployment rate would be 13% had we not had the package, but it is worth noting that there was major, major concern in the winter of 2009 that the economy was in or approaching "free fall" and I think the stimulus had not only a direct effect in spurring spending but also an indirect effect, in essence letting people know the government was not going to stand idly by, preaching the wonders of the market miracle, while the economy drove off the cliff. So, count me as a fan of the stimulus package.

Is it fair to say that military spending is among the least productive economic stimulators that the federal government spends? Do you see much political will yet to seriously consider cutting military spending? Would you advise this?

A: William G. Gale

We certainly have to address defense issues as part of the budget package and Sec Gates has already made some moves on that front. In the short run, as Harvard professor Martin Feldstein has proposed, doing needed maintenance on military machines and equipment would be a good way to get spending going now -- and we know we need to do that anyway.

I think it is clear that the military should be subject to budget constraints and forced to set priorities and make choices just like the rest of us, but not being a military expert I would not want to make those particular calls myself.

There were news stories last week about "patriotic millionaires" (not to comment on the terminology) who agreed their taxes should be raised for government fiscal reasons. What constituencies make the best targets for "patriotic cuts," that is, who agrees THEIR OWN government outlays should be reduced?

A: William G. Gale

This is a good question, fun to think about and important. Having thought about it now (very breifly), I am guessing that there is more variation within each major group in cutting benefits or raising taxes than there is across groups. That is, I would guess that in any big group (SS recipients, farmers, high income taxpayers, Medicare recipients) there are some who are willing to say that the benefits are excessive and or the taxes are too low and some (many) who wouldn't. That's just a first impression, though. It'd be interesting to know if people have thought about this more systematically.

How concerned should we be over the size of our national debt? It seems astounding to me that anyone lends our government money. Is there any chance we could ever repay the current debt, not to mention how much our deficit spending keeps on adding to it?

A: William G. Gale

This relates a bit to the question about how we measure the deficit. One reason analysts like to focus on the long-term outlook rather than the short-term outlook is that all of the different measures of the deficit give the same answer (bad!) in the long run.

So, as to why people lend us money, the US government is still an extraordarily safe and secure lender. I fervently hope we do not mess that up with politicians playing "chicken" around the extension of the debt ceiling in April. Yes, we can repay current debt. Current debt levels are not particularly high -- it'd be better if they were lower but they aren't the real problem. The real problem is that we are on an unsustainable path.

I find the Fiscal Commission' s proposals to be curious. How does reducing the size of the government workforce, cutting 250,000 contractors, placing monetary restrictions on education and the Department of Justice, and rolling back various administrative agencies serve to create jobs and stimulate the economy? To me, it seems that these proposals will signal the final nail in the social and governmental network left from the New Deal era. and where are reductions to defense spending?

A: William G. Gale

I have been struck by how much of the burden would be borne by government workes (or lack thereof) in the Commissions draft report. The Commission (technically, the DRAFT report of the COCHAIRS of the commission) had to come up with cuts that would get the deficit down by 2015. They focused those cuts on discretionary spending more than one might have expected. Cutting the workforce is not going to deal with the long-term deficit though simply because it is not a big enough spending ite,

we have a spending problem, and not a revenue problem. S eriously. I believe that our federal govt has enough money. And raising taxes will only decrease the amount to the Treasury in the long run, anyway.

A: William G. Gale

I disagree that it is "just" a spending problem. The thing t notice is that it is the current services budget that goes off of the deep end in the long run. it is not a big expansion in government services or programs, it is the continual running of current programs as the population changes. One can argue coherently that maintaining current services is "part of the deal" and that taxes should rise to pay for them. One can also argue coherently that keeping taxes at a relatively fixed share of GDP over time is "part of the deal" and so spending per capita should be cut sharply. I personally end up in the middle -- we have two "deals" that are becoming mutually inconsistent -- and I think we are going to need to compromise between the two extremes. I don't see this, though, as "just" a spending problem.

Can presidents cut the deficit acting unilaterally, and if so what are spending areas in which a president can take such action? If not, have past actions/plans by Congress and presidents been successful in cutting federal deficits, and if so when and by how much?

A: William G. Gale

There are a few things the President could do, but remember that the vast majority of government spending is on a few items -- defense, SS, Medicare, Medicaid, net interest -- and those can't be affected unilaterally.

We all are aware that the current National Debt is not sustainable. What is the range of a sustainable National Debt?

A: William G. Gale

Well, here's the problem. No one actually knows what "the" level of (un) sustainable debt is. Historically, it has varied across countries and of course it depends on a wide variety of other factors, like economic strength. But we do know that the US is headed down a path that is not sustainable.

Bill--as you know, cutting the deficit in the long run is going to require serious adjustments to health-care spending. So budget analysts and policymakers are faced with finding the big bucks, so to speak. And by all indications that I've seen, a solid one-third of total Medicare spending goes to chronically ill patients in the last year or two of their lives. I don't want to make this about "death panels," but (as even President Obama has said), there is a real trade-off between simply extending life and extending life in a way that allows the patient to actually enjoy themselves outside the confines of the ICU. So isn't the crux of the long-term deficit problem about Americans' difficulty with facing death? That inability to accept inevitable death is costing billions every year--a recent PBS Frontline episode pegged the cost (roughly) at $20 to $25 billion annually. Our ability to prolong life, regardless of the quality of that life, is a real dilemma--and I don't see how we will ever control medical costs without facing up to this issue.

A: William G. Gale

Yes, health care is a big problem for the budget. Yes, there are high end of life costs. A few thoughts on all of this

--it is not clear to me how one knows whether one is in an "end of life" episode or not. Clearly, if one is not or has the chance to avoid that, the case for spending money is different than if one is.

--second, the social problem isn't so much that people spend alot on health care, it is that they spend a lot of public money on health care. So, we either need to find a way to move health spending on to private budgets or a way to better prioritize public spending. The only way to do that is .... rationing of some sort, a dirty word, I know (so call it something else) but that is the issue. My colleague Henry Aaron has been making this point for almost 30 years now and he's right.

Subsidizing farmers and ranchers not only distorts the market, but, in the case of big factory farms, is environmentally destructive. Why is eliminating farm subsidies so rarely mentioned as a way to cut spending?

A: William G. Gale

Oh, it's mentioned, it just never goes very far. I think among urban policy wonks, getting rid of farm subsidies is a very favored idea on grounds of budget, economy, equity, environment, on and on. The problem is the Senate, where every state has two votes!

the Bush 'tax cuts' "aid only high income households" is kind of misleading. Those are the people that have the jobs to give others. When they have less, there would be fewer jobs. It might be getting rid of the lawn guy, getting your hair done less, etc., etc. (or tipping less) - but when you have less you spend less. Why do we think the govt is doing a better job than those with upper incomes? Those are the ones who have the jobs to give. Creating more govt jobs isn't the way to grow an economy.

A: William G. Gale

So, we can't seem to get past the Bush tax cuts!! Let me close with responding to this statement, which is heartfelt but is ideological and not evidence based. The evidence and analysis indicates, over and over again, that there are better ways to get a weak economy going (remember the need here is for aggregate demand) than extending tax cuts to the wealthy.